Deflation

DEFLATION. - A phenomenon whereby the volume of means of payment comes, for various causes, to diminish relative to the mass of goods that are the object of exchange.

In order to understand d. in its scope and in its effects, it is necessary to start from the so-called equation of exchange, which serves essentially to bring to light the relationship linking the amount of the means of payment on the one hand and the total of the goods exchanged on the other, with the general level of prices. Its statement is: the volume of money is equal to the general level of prices multiplied by the quantity of goods exchanged. One sees at once that between the level of prices and the volume of money there is direct proportionality, whereas between the level of prices and the mass of goods that are the object of exchange there is inverse proportionality. This appears from the transformation of the formula, whereby the general level of prices is equal to the ratio that exists between the volume of money and the quantity of goods exchanged. Strictly speaking, therefore, a decrease in the general level of prices may derive either from a decrease in the volume of money or from an increase in the mass of goods exchanged. Except in exceptional cases (wars, earthquakes, etc.) this second factor is normally stable, varying significantly only over long periods of time. The amount of the means of payment, on the other hand, may undergo appreciable contractions while the other factor remains unchanged; and it is in general to this phenomenon that almost all the d.'s verified so far must be attributed. Therefore it must be held that d. consists more in an absolute diminution of the volume of money than in a relative diminution of it as an effect of the increase in the mass of goods. It is worth recalling that one can speak of a truly deflationary process only when this reaches an intensity such as to be reflected in the level of prices with a fall of some significance.

Whereas usually the expansion of monetary circulation, that is, inflation, is not deliberately practised by the responsible organs, d. represents in every case a voluntary and conscious act. By deflationary policy the aim is normally to bring currencies, depreciated by inflation, back to their previous value or in any case to a higher value, when the more limited objective of monetary stabilization is deemed insufficient. After the war of 1914-18 several countries that had suffered serious devaluations adopted deflationary policy, and among them Italy, but it was England in particular that carried this experiment through to the end. As some economists had warned, the results achieved, when they were achieved, cost painful sacrifices and provoked profound crises of readjustment. In fact, given that entrepreneurs usually bear a large part of production costs before the sale of the finished articles and are often bound by long-term contracts, the fall in prices is not matched by an immediate decrease in costs, and therefore the activity of the firms results in loss. This causes on the one hand a slowing down, which can reach the point of paralysis, of the productive rhythm, and on the other the formation or the worsening of unemployment in every category of those employed in production. At the time it was nevertheless maintained that d. was necessary in order to remedy the injustices that had arisen in the distribution of wealth and incomes as a consequence of monetary devaluations. In fact it is well known that inflation harms creditors and favours debtors, and while it is to the advantage of the active economic categories of entrepreneurs and merchants, it compromises instead the situation of those who enjoy fixed incomes. Apart from the drawbacks complained of, it was found that d. is in this sense counterproductive, in fact consolidating the advantages obtained through inflation, while usually, especially through unemployment, it aggravates the damages of those classes for which a better justice is invoked.

Recourse to deflationary manoeuvres is on the other hand legitimate and useful when the intention is to remedy, by lowering the level of domestic prices, an imbalance that has arisen with respect to the trend of international prices.

Ercole Calcaterra